SEC Issues Risk Alert on ESG Investing

SEC Issues Risk Alert on ESG Investing

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On April 9, 2021, the Securities and Exchange’s Division of Examinations (the “Division”) issued a Risk Alert related to firms’ practices on environmental, social and governance (“ESG”) investing. This follows the formation of an ESG task force within the Division of Enforcement. Investor demand has increased in recent years, including: (1) seeking to invest in ESG strategies and/or (2) expecting managers to have internal ESG policies (for example, diversity in hiring, selecting service providers, community involvement and the like). The challenge for managers is that ESG investing means different things to different clients or fund investors. While it is natural to want to meet that demand, firms should not attempt to be all things to all people. Indeed, it would be impossible to account for every ESG-related metric. Rather firms should consider the issues that matter most to them, whether they are building out internal policies and procedures, launching an ESG strategy or both.

Unsurprisingly, the SEC is seeking to understand the landscape of ESG investing and assessing firms’ policies and procedures in core compliance areas. The Risk Alert highlights deficiencies and weaknesses from examinations of investment advisers, as well as areas in which firms have been effective in complying with regulatory expectations. The Division will focus on the following when examining firms with ESG strategies:

  • Portfolio Management: Examinations will include review of ESG policies, terminologies used, due diligence for selecting and monitoring investments, and how firms handle proxy voting in ESG investments.
  • Performance Advertising and Marketing: All disclosures in offering documents, regulatory filings, websites/social media and other marketing materials will be under scrutiny.
  • Compliance Programs: The Division will focus on firms’ internal policies related to ESG initiatives.

In particular, the Division has observed the following deficiencies:

  • Portfolio management practices were inconsistent with disclosures about ESG approaches. One example is when the Division noticed a lack of adherence to certain global ESG frameworks, despite disclosing such adherence in client-facing documents.
  • Controls were inadequate to maintain, monitor and update clients’ ESG-related investing guidelines, mandates and restrictions. The Division noticed weaknesses in implementing or monitoring ESG investments, or a total lack of an ESG program, despite marketing one to clients.
  • Proxy voting may have been inconsistent with advisers’ stated approaches. ESG policies should exist and be adequately implemented. Firms should consider disclosing that policy to investors separately from policies related to other investments.
  • Unsubstantiated or other potentially misleading claims regarding ESG approaches. Performance is subject to a high level of scrutiny for being potentially misleading or inaccurate. All marketing related to the benefits of ESG investing must be substantiated. Firms should ensure that any benchmarks they use are relevant and periodically reviewed to ensure continued relevance and usefulness.
  • Inadequate controls to ensure that ESG-related disclosures and marketing are consistent with the firm’s practices. Policies should have controls over content related to ESG investing, updating documents for material changes, and ensuring that content aligns with investment decisions.
  • Compliance programs did not adequately address relevant ESG issues. The Division observed that some firms lacked policies and procedures related to an ESG program at all. Firms should establish and periodically review their policies and procedures with respect to their ESG programs and strategies.
  • The staff observed that compliance programs were less effective when compliance personnel had limited knowledge of relevant ESG-investment analyses or oversight over ESG-related disclosures and marketing decisions. Firm compliance professionals did not know how to respond to client requests and due diligence questionnaires, and how to substantiate ESG-related claims.

The Division also noted some aspects of ESG-related compliance programs that worked:

  • Disclosures that were clear, precise and tailored to firms’ specific approaches to ESG investing, and which aligned with the firms’ actual practices. Division staff observed that there were clear disclosures in client-facing materials related to portfolio or separately managed account offerings. Additionally, some firms were able to satisfy the requirements of certain global ESG frameworks while not necessarily engaging in ESG investing. In such cases, disclosures should state that adherence to these frameworks does not necessarily alter contrary investment strategies. The Division also noted that some firms had detailed explanations on how they followed global ESG frameworks in client-facing materials.
  • Policies and procedures that addressed ESG investing and key aspects of relevant practices. Adequate policies and procedures required documentation at various stages of the ESG investment process, particularly when multiple ESG investing approaches were employed at the same time.
  • Compliance personnel that were knowledgeable about the firms’ specific ESG-related practices. The Division noted that firms were better able to manage ESG compliance programs if their compliance personnel were knowledgeable about the program and could answer due diligence questions.

From a regulatory perspective, managing an ESG strategy is actually nothing new. Firms should consider the core compliance areas of marketing and adherence to stated investment strategies as they relate to their particular business and strategies.  This includes documentation of processes, investment decisions and disclosures to investors. Though not required, firms that manage ESG strategies should consider establishing internal ESG initiatives, particularly those that align with their strategies.  Ultimately, both investors and regulators will expect firms to mean what they say when it comes to ESG.  The Greyline team is happy to discuss the Risk Alert, other ESG matters and/or assist with developing or reviewing existing policies and procedures.

The full Risk Alert can be viewed at SEC.gov.

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Darren Mooney

Partner and Co-Head of Business Development

Darren Mooney is a Partner and the Co-Head of Business Development at Greyline. Before joining Greyline, Darren served as deputy chief compliance officer of Partner Fund Management where he held primary responsibility for the compliance program of the second-largest hedge fund in the Bay Area. Prior to that, Darren spent five years providing compliance consulting services at Cordium and then ACA Compliance Group, where he led the company’s San Francisco office and west coast operations. In addition to providing ongoing consulting services to a variety of investment managers, including hedge fund, private equity, venture capital, real estate, quantitative and other wealth managers, Darren also regularly guided clients through the SEC registration process, implemented tailored compliance programs, supported clients’ live SEC exams, and served as an SEC-mandated independent compliance consultant following an SEC enforcement action. Darren’s other experience includes serving as deputy chief compliance officer and associate counsel at F-Squared Investments where he directly supported the compliance program during the investigation and subsequent enforcement regarding historical advertising practices. Darren has a B.S. in Economics from the University of Delaware and a J.D. from Suffolk University Law School. He is a member of the Massachusetts bar.

Annie Kong

Partner and Head of Venture Capital
Annie Kong is a Partner and Head of the Venture Capital Division at Greyline. She provides ongoing compliance consulting to investment advisers and manages client relationships. Prior to joining Greyline, Annie was part of compliance and operations at a long-only manager-of-managers that advised pension fund clients. While there, she conducted compliance and operational due diligence on SEC-registered investment advisers on the platform. She also oversaw and counseled on various legal matters across the firm. Annie has a B.A. in Economics from the University of California, San Diego, and a J.D. from the University of San Diego School of Law. She is an active member of the State Bar of California.
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